Foreign Direct Investment in Services and Manufacturing Productivity: Evidence for Chile

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Foreign Direct Investment in Services and Manufacturing Productivity: Evidence for Chile

Ana M. Fernandes a The World Bank

Caroline Paunov b OECD

March 2011 Journal of Development Economics forthcoming

Abstract This paper examines the impact of substantial foreign direct investment (FDI) inflows in producer service sectors on the total factor productivity (TFP) of Chilean manufacturing firms. Positive effects are obtained in firm fixed effects instrumental variables regressions and show that forward linkages from FDI in services explain 7% of the observed increase in Chile’s manufacturing users’ TFP. Our findings also suggest that service FDI fosters innovation activities in manufacturing. Moreover, we show that service FDI offers opportunities for laggard firms to catch up with industry leaders.

Keywords: Total Factor Productivity, Service Liberalization, Foreign Direct Investment, Chile, Firm Heterogeneity. JEL Classification codes: D24, L8, L9, F21, F23.

a

Ana Margarida Fernandes (corresponding author). The World Bank. Development Research Group. 1818 H Street NW, Washington DC, 20433, U.S.A. Email: afernandes@worldbank.org. b Caroline Paunov. OECD. Directorate for Science, Technology and Industry. 2, rue André Pascal, 75 775 Paris Cedex 16, France. Email: caroline.paunov@oecd.org and caroline.paunov@gmail.com. This paper is a modified version of the World Bank Policy Research Working Paper 4730. The authors would like to thank Eric Verhoogen (the co-editor) and two anonymous referees as well as Richard Disney, Ana Paula Fernandes, Jonathan Haskel, Beata Javorcik, Raimundo Soto, Peter-Paul Walsh, and seminar participants at Indiana University, the Chilean Central Bank, the University of Chile, Queen Mary University of London, the 6th International Industrial Organization Conference, the OECD Development Centre, the 2008 Empirical Investigations in International Economics Conference in Slovenia, the 2008 North American Summer Meetings of the Econometric Society, the 2008 EEA ESEM Meetings, the 2008 European Trade Study Group Conference, 2008 LACEA-LAMES Meetings, the 4th MEIDE Conference in Estonia for valuable comments. Support from the governments of Norway, Sweden and the United Kingdom through the Multi-Donor Trust Fund for Trade and Development is gratefully acknowledged. The findings expressed in this paper are those of the authors and do not necessarily represent the views of the World Bank or the OECD.

1. Introduction Foreign direct investment (FDI) inflows into the service sector experienced a boom during the 1990s. By 2002, services accounted for 60% of the world stock of FDI, a fourfold increase since 1990 (UNCTAD, 2004). In developed and developing countries alike, the main recipients of FDI have been profit-seeking producer services which range from network-intensive services such as electricity, telecommunications, and transport to finance and business services. These sectors are characterized by the facilitating and intermediating role which they play for downstream user firms (Francois, 1990). Thus, producer service sectors are an intricate component of a country’s business environment. In emerging economies where manufacturing firms are constrained by cumbersome business environments, it is particularly relevant to understand how the performance of service sectors can be improved and how that supports business development and, thus, overall economic growth. FDI is a potentially powerful means to achieve such improvements as it might increase the quality and variety of services available as well as lower their cost. Manufacturing firms may benefit from their interaction with foreign services suppliers through spillovers of management, organizational, marketing, or technological knowledge (Markusen, 1989; Rivera-Batiz and Rivera-Batiz, 1992). Despite the relevance of this topic, the effects of vertical linkages resulting from the openness of producer services to FDI on downstream...
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